Best move for cash-strapped states? Raise progressive taxes.

Raising progressive taxes is a better move than budget cuts. It gets money moving through the economy again, jump-starting the economic recovery that is the principal engine of state fiscal health.

ByKaren KrautMay 10, 2010

Boston — All but a handful of states have seen their revenues plunge since the great recession hit like a tsunami in 2008. State lawmakers have repeatedly slashed their budgets to address the massive shortfalls. But cutting to get out of fiscal crisis is tantamount to digging to get out of a crater.

Budget cuts deepen the recession and stifle recovery by immediately putting people out of work, reducing public and private investment, and abandoning residents in their hour of need. The long-term economic consequences are also damaging, including lost productivity, a less-skilled workforce, and reduced competitiveness.

The key to the twin goals of budget repair and economic recovery is significantly increasing progressive taxes.

Not "progressive" in a political sense of generally favoring taxation, but in the economic sense of taxing individuals and businesses based on their ability to pay – a viewpoint shared by Adam Smith, pioneer of market-based economics.

While naysayers claim that increasing taxes during a recession is unwise and counterproductive, it will work if you pick the right taxes.

Progressive taxation raises revenue, underwrites critical public investment, stimulates additional private investment, and maximizes job retention and creation. In the long run, progressive taxes are among the most sustainable revenue sources and result in more widely shared prosperity.

Of course, in a recession it would be better if the federal government sent funds to cash-strapped states – as Congress did to a limited extent in 2009 with the American Recovery and Reinvestment Act – or if states, like the federal government, could engage in unlimited borrowing.

Since neither of these are options, governors and state legislatures must realize they have at their disposal a sound and effective alternative to cutting their way out of the red.

Consider Virginia, a state that has cut its budget by $4 billion over the past 2-1/2 years to address a massive shortfall. Had Virginia lawmakers opted for progressive tax reform, they would have raised enough revenue to prevent virtually every painful cut, preserved jobs, and kept money flowing in the economy.

Virginia could have made its personal income tax more progressive by eliminating the deduction it allows for federal itemized deductions – a benefit enjoyed primarily by upper-income taxpayers. That measure would have raised $1.6 billion per year. Virginia could have raised an additional $400 million annually in new revenue by modernizing its income tax brackets to make them more progressive.

Progressive tax increases are the centerpiece of a recent report issued by the Tax Fairness Organizing Collaborative, a project of United fora Fair Economy. Other pragmatic measures to close state budget gaps recommended in the report include timely use of rainy-day funds, repealing unworthy tax expenditures, strategic borrowing, and building retirement and trust funds wisely.

But there's still more to be done: When state governments have raised taxes to close budget gaps, they have too often increased sales taxes, fees, and less visible excise taxes. These types of taxes and fees fall most heavily on low- and middle-income people and dampen the potential for greater economic activity and shared prosperity.

The political will to enact these common sense reforms is building. In Oregon, voters decisively approved two ballot measures that raised income taxes on upper-income residents and corporations. New York and Rhode Island both passed upper-income tax increases. Though those increases weren't substantial enough to prevent deep budget cuts, they were on the right path.

It is critical that states not settle for ineffective approaches likely to prolong the economic downturn or delay recovery.

Progressive taxation is a state's most effective antirecessionary tool. It gets money moving through the economy again, jump-starting the economic recovery that is the principal engine of state fiscal health.

Karen Kraut is the director of the Tax Fairness Organizing Collaborative.